Developing a costing system that will meet the requirements of Malesela Technologies

Abstract:

The costing system currently in use at the company under investigation, does not address the underlying problems and shortcomings such as cost price, total cost and selling price computations, or fixed cost management. The importance of cost price and total cost computation is vital for accurately determining the following. (1) Determining the amount of costs or expenses capitalized in ending inventory in terms of valuation. (2) Basis for determining a selling price for goods or services. (3) Determining the amount of costs transferred to good output. (4) Determining the amount of income tax payable. Recommendations for solving these problems could be made by examining the usefulness of the currently applied traditional costing system in respect of basic cost and management accounting principles. The traditional costing systems, such as the Absorption Costing System, Variable Costing System, and the Activity Based Costing System, will be evaluated and analysed for the purpose of developing a system with all the necessary characteristics to make it an appropriate system. The traditional "Absorption Costing System", which is supported by GAAP, will operate properly only under ideal conditions should production and sales volumes be the same. Due to the fact that ending inventory is hardly ever valued conservatively, the absorption costing system cannot be used for the correct computation of a cost price, total cost or pilot selling price. The computation of cost prices would make much more sense if terms such as cost, expense and cost price were clearly defined. Break-even points would be reliable only under ideal conditions. In the absence of guidance for the calculation of spare capacity costs, it often happens that these undefined costs are incorrectly added during inventory valuation. The absorption costing system also fails in the proper and timely provision of management information. As a system, it cannot give guidance when management is required to bid against competitors for the supply of goods and services, and consequently, is a poor performer when matching income with expenses in order to determine profit. Sensitivity analysis (combination of risk and uncertainty) can be performed only with great difficulty. In contrast with the previous system, the "Variable Costing System" is a very good system for profit determination by the matching of income with expense. Furthermore, it complies with the requirements of GAAP in terms of AC 108 for the computation of a conservative cost price. It effectively serves the requirement for providing timely management information and to separate cost price from spare capacity costs. All period costs and expenses are being taken into account, including spare capacity costs that are recovered in the income statement. This system will provide the correct information to perform sensitivity analysis (combination of risk and uncertainty). One of the shortcomings of this system is that variable costing does not provide management with the total cost information required for cost price calculation and for bidding against competitors in terms of goods and services to be sold or rendered. No fixed production costs or expenses are recovered with costs transferred to good output. As an extension of the absorption costing system, "Activity Based Costing (ABC)" also allocates indirect overhead costs to the product for cost price computation and for providing management information. The designers claim, that a more accurate cost price could be calculated and that the activity costs could be better controlled. The requirement, as stated in AC 108, for the conservative computation of cost price, is completely ignored. In addition, other non-production costs are incorporated in the calculations of the cost price. All costs are incorrectly classified as variable and consequently the existing fixed costs are ignored. This results in failure to manage fixed costs and is, therefore, a poor system for determining profit by matching income with expense and separating cost price from spare capacity costs. Efficiency and productivity measurement and control are important requirements for management information and are not a feature of ABC. As a costing system, it fails to provide management with correct total cost information for bidding against competitors for the supply or rendering of goods or services. As summarized from the above, it would seem clear that no specific costing system provides management with the necessary total cost information required for bidding against competitors. This is a definite requirement in this company, because the market largely determines the product's selling price. Therefore, accurate total cost information is vital. At this stage, management largely relies primarily on intuition. The claim that market forces regulate selling prices, should not be accepted as an indication of selling price, but rather as a motivation and reason to investigate, manage and control total cost. This would highlight problem areas and result in the more effective and efficient use of resources, which would in turn, improves profit. It is normal for two suppliers of a common product to have different selling prices. Research indicates that differences in expense items such as rental charges, wages and salaries, gross margin policies etc., because selling prices to fluctuate. This research will try to provide guidance on the problems surrounding the calculation of cost price, total cost and the proper recovery of costs and expenses, and properly calculating a selling price, where possible. Can the current costing systems, in collaboration with the Generally Accepted Accounting Practice (GAAP), offer solutions to cost and selling price calculations and expense and cost recovery problems? None of the current costing systems meets the requirements for cost price calculation, provision of adequate management information for bidding, and for proper cost and expense recovery. Neither is guidance offered for fixed cost management. This can be achieved only by making use of a "hybrid costing system" and supplementing it with certain features not addressed in either. This study revolves around the application of cost and management principles to investigate and evaluate the currently employed costing system of the company under investigation. The primary aim is to determine which problems are not addressed in the current system and how these shortcomings could be solved. It is essential to evaluate the available costing systems in terms of the cost and management principles, as well as in terms of management requirements. This study will make it possible to determine the following. (1) Can the available costing systems comply with these requirements? (2) Can the current system be adjusted to address the outstanding requirements? (3) Is it necessary to develop a new system to solve the problem and comply with the requirements? If a new system is required, the secondary aim of this study will be to develop a new system that would solve the problems and shortcomings identified hereafter.